How Does Mortgage Amortization Work?

The accounting period for mortgage amortization considers that there are 12 payment days in each calendar year. These days fall on the 1st of each month. The actual mortgage account commences on the 1st day of the month that follows the day your mortgage loan becomes active. The first payment you make is known as "interim interest" and occurs between the period of the day your mortgage becomes active and the day your account begins. Subsequent repayments for your mortgage loan begin on the 1st day of the month that follows. So, if we consider as an example that a 30 year mortgage of $200,000 at a 6% interest rate becomes active on 15th January, you will pay interim interest of $1199.12 for the period when your mortgage loan becomes active (15th January - 1st February) with your first actual payment due on 1st March.

Mortgage loan payments are split: part of your payment goes towards interest on the mortgage loan and part goes towards reducing the balance of the loan itself. Interest payments are calculated through multiplying 1/12 of the rate of interest by the mortgage balance of the previous accounting period. So in our example, 1/12 of 6% is 0.005. Consequently, the interest you would pay on March 1st would be:

0.005 x $200,000 = $1,000

The remainder of the $1,199.12 ($199.12) goes towards the principal balance, reducing it to $199,800.88. Principal payments are a residual: i.e. the difference between the total payment amount and the interest owing. The mortgage payment process continues for each monthly accounting period throughout the term of the mortgage, with the interest payment slowly decreasing as the principal payment increases. So on the 1st March the interest calculation would be:

0.005 x $199,800.88 = $999.01

The principal would be reduced by $200.09 (the remainder of the $1,199.12 payment after interest), leaving the principal at $199,600.79.

Penalties for Late Payments

Although most lenders will offer a "grace period" to borrowers, whereby payments can be deferred from the 1st of the month up to around the 15th, mortgage amortization payments that arrive after the 15th would normally be subject to a late payment charge of up to 5% of the normal monthly payment amount.

Amortization and Overpayment

If you decide to overpay your agreed minimum amortization payment, you can effectively reduce the mortgage principal by the amount of the overpayment. Using the above scenario as an example, if you were to pay $2,199.12 on the 1st March you would reduce the principal to $198,600.79. This enables more of the principal to be reduced in subsequent payments as the ratio of interest payment to principal payment has been dramatically changed.

Tools to Help You Amortize Your Mortgage Loan

One of the best tools to use are mortgage amortization schedules, which help you to see how the ratio of interest to principal payments change over time. An amortization schedule can be quite nicely displayed through the use of spreadsheet templates that hold all the amortization formulas you need enabling you to make "what if" scenarios on the fly to see how that changes the picture of your mortgage over time. Many websites offer free amortization spreadsheets with no strings attached.